After going online with its second production line—a first of the many expansions cement companies are bringing—Cherat is entering a different league. There are five factors which have impacted its bottom line for the first half of FY18 which shows an impressive growth of 32 percent despite several roadblocks. In fact, the EPS at Rs4.2 in 2QFY18 exceeds expectations of a handful of brokerage houses that estimated it to lie between Rs2.6 to Rs3.5.
The first factor is the new expansion (1.3m tons), which has bagged the company a higher chunk of the market share. On an estimate, Cherat’s contribution to industry dispatches has grown from 3 percent to at least 6 percent. As a result, the first quarter of FY18 saw a dispatch increase of 156 percent (industry growth: 15%) translating to a revenue increase of 120 percent. The second quarter saw a revenue increase of 60 percent.
This brings us to the first roadblock: retention prices and price discounts. The sector has been witnessing a period of high volatility in prices especially after Cherat’s additional capacity came online. Retention prices have fallen by an average Rs25 per 50kg bag. And this volatility will continue once more expansions in the north come through as cement makers crumble under the pressure of idle capacity. (Having said that, things aren’t written in stone as currently there is a moratorium on expansion in Punjab imposed by regulators).
Some cement companies—including Cherat—have also been giving discounts (Rs10-20 per bag) to clear excess volume faster. This is why at an industry capacity utilization of 95 percent in 1HFY18; revenues for the industry will be lower. For Cherat, revenues have clearly not grown proportionately with the growth in dispatches.
The second major issue is input costs. Rising oil and coal prices have put an inordinate amount of pressure on gross margins. At 1HFY18, Cherat’s margins stood at 25 percent where they used to be upwards of 40 percent the same period last year. On average, coal prices were $75 per ton in July-Dec16 but grew to $86 per ton in July-Dec17. In Nov-17 and Dec-17 at $89-90 per ton, they were the highest since 2013. Combine it with freight costs, and it is clear why margins have plummeted.
The third concern is finance costs. Having launched its second production line, for which it is still paying the depreciating and finance fee, the company is now commissioning its third production line. For the latter, long-term loans have already been negotiated which will continue to put pressure on expenses going forward. However, one cost cutting measure is the commissioning of three new Wartsila Diesel engines (30MW) will bring down long term costs of production.
On another positive front, the company doubled down on its indirect expenses which were 9 percent of revenues in 1HFY17, falling down to 5 percent in 1HFY18. With lower indirect expenses, but significantly high costs of production and finance costs, the company saw a decrease in its before-tax bottom line. Saved only by our fifth driving factor: tax benefit.
Because of the capital expenditure on expansion, the company enjoyed a lower effective tax that helped boost its profit-after-tax. As a result, profit margins did not fall as much as they should have in absence of this provision. Had effective tax remained the same as last year, profit margins in 1HFY18 would be approximately 13 percent instead of the current 18 percent. Not too shabby!
Fluctuation input prices, falling retention prices and rising finance costs will continue to be the bane of Cherat’s margins going forward.